The BoJ will likely hike higher and faster

We now expect the Bank of Japan (BoJ) will raise its policy rate in September and December this year and in April 2027 to reach 1.75%. This is a higher policy rate projection and a faster pace than we previously anticipated. We think the BoJ will want to address the pressure on the yen and the rise in inflation expectations. We also now project the nominal neutral rate is 1.75%, up from our prior estimate of 1.5%, reflecting higher inflation expectations. We maintain our estimate of the real neutral rate.

The US-Japan joint intervention in late July had a short-lived impact on the yen but has increased pressure on the BoJ to accelerate the pace of rate hikes. Financial markets appear to reflect the idea the US Treasury Secretary demands faster rate hikes in exchange for intervention. The economic and political cost of disappointing markets and the US has become too big for the BoJ and the government to ignore.

Our new policy outlook is subject to high uncertainty. While faster rate hikes are needed to defend the yen, more gradual rate hikes may be deemed necessary as the policy rate nears the neutral rate. On the other hand, if the yen weakens further from our baseline assumption due to rising fiscal concerns, the BoJ may need to hike the policy rate further to 2% in July 2027.